Beginnings – False Prophets

I can still remember a friend telling me that you will want to learn about options. The conversation had to do with reducing risk, and portfolio protection. I went and picked up a book on options and started reading it. Unfortunately I got a headache within the first 10 minutes and found the subject quite confusing. So one day, I signed up for a fairly expensive options class taught by one of those companies that takes over the airwaves before they come to your town. They draw you in with a teaser to sign you up for their options class. I signed up along with a good friend of mine. Confidence in numbers.

The classes were held on the weekend and I had to take one day of vacation from work. I was pleasantly surprised to find a large hall full of eager people wanting to learn options and make money. Some of them did not know the ABCs of trading, and here they were suckered into learning options! My primary objective was to understand how to use options to protect my positions. Just before the class began, in walks in one of the big names in the business – one of the co-founder and leaders of the company who’s class I was taking. I will not mention his name as I do not want to get into name calling here. But when he introduced himself, the atmosphere was electric. And we were excited.

He started of by asking us who used what technical analysis tools and pretty much derided all of them and told us he would tell us about “the method” which we would use to make lots of money with, because it was not commonly used but was incredibly accurate. He was talking about Elliott waves analysis using a major software available then and today. During the class he did a search and brought up 5 stocks ready to do wave 5 and each one had met all the rules and had targets that showed the risk:reward ratio was perfectly in line for the trade. Of course I jumped into about 4 of them with some small call and put positions with real money. After all this was the prophet telling us a sure thing and why not use the class learning to pay for the cost of the class. After all I was going to double my money in six months or money back.

You can imagine what happened next. After a month, I found that all his picks were all losers. And not only that, all my wave numberings on my software chart had changed in a month. I could not understand that.

The first lesson I learned was - do not believe these shysters out there. Most of them are just very good at yapping and selling, and that is why they make money, not trading.

Second lesson:  Elliott waves analysis will number the waves on your chart one way but when the stock behaves differently from the numbered wave counts over time, the software will re-number the waves. The chart always looks good on paper; but it is extremely hard to trade it and to make money of it. I do have a good friend who loves Elliott waves and he will take exception here. But I thought when you saw signals on a chart they occurred in the past and not adjusted after looking into the future! Wish they had told me that in the beginning! In case anyone is interested here is the Wikipedia reference to Elliott waves:  http://en.wikipedia.org/wiki/Elliott_wave_principle.  I think it is a good tool to know – that human psych works in waves; but not a great tool for timing and trading.

And the third lesson: proceed with your learning cautiously and test - backtest your ideas in a manner that gives you confidence to trade before you put real money on the line.  I did learn about options and I think that learning was well worth the price of the course. It is that background that helped me eventually develop my dynamic hedge method to manage stocks while controlling risk using both stocks and options.

SPY exit signal 2/23/11

Looking at my SPY chart I see that my trading system has given me an exit signal at the end-of-day today, signaling it is time to get out of the long positions. The exit signal is rather small on my chart. It looks like a small blue bubble. But what a long ride it was, starting from back in September 2^nd, 2010. See attached chart.

The nature of these signals is that we do not know how long the down side will last. It is impossible to predict the strength and duration of the down side. That is why as a minimum, I will put in protective portfolio insurance on my 401K. Actually I had placed a partial position last night for market open today and after I came home from work, I was happy to see that my order took. It was a limit order. I will wait for a small bounce to install the rest of my position. Next time I will write about portfolio insurance. Here is a hint: We have cars and buy car insurance on it. We buy a house and buy home insurance on it.  So why don’t we have 401K portfolio insurance?  Because most investors do not know what it is, and even many financial advisors don’t know or how to use it effectively. More on it next time….

Fast Forward

Let me fast forward the previous chart set in 2001 – 2002 in my last blog to the last several years, 2004 – 2011. The chart itself is a weekly chart of ARTQX, Artisan Mid-Cap Value mutual fund. It is one of the choices I have in my 401K portfolio with the last company that I was with. The smooth blue line close to the jagged price line graph is a 9 period exponential moving average (EMA), the orange line a 50 period EMA and the green line a 89 period EMA. Here each period is a week.

It becomes abundantly clear that if one was invested when the line graph representing the mutual fund’s price was blue, one would have left many of the recession headaches behind, and enjoyed the lengthy Bull Run upwards. Price drops very fast. Usually price drops 3 times as fast as it climbs up. When the price line turns red, pull your money and put it in a safe haven like a money market fund or some other mutual fund that is blue. Each line is drawn week-to-week and there is not much time to hesitate. In 2008 if one hesitated after the price graph turned red, then severe losses could have occurred. One could easily see a 15-25% drop in fund value.

If the price line graph is blue, then invest long in the ARTQX Mid-Cap Value fund. Usually that would probably be a bond fund like the Fidelity Govt Income fund, which can behave contrary to the equity type funds. Nothing is guaranteed and it is best to actually see the fund with the trading system. I am currently invested in one of the Artisan Mid-Cap funds in my own 401K portfolio.

There are no guarantees as to how long the price line graph will stay blue. We are overdue for a correction. The current bull run began last September and it may very well be time to pause and take a breath. But if I use the simple rule of staying long when blue and getting out when red, the system would take care of letting me enjoy the lengthy bull runs upwards, and cut my losses quickly. It is likely that I will get whipsawed sometimes. That is also part of the reality in investing.

Beginnings 2 My first trading system

I came back from the Saturday morning Equis presentation on Metastock with software in hand. I had just bought my first on-line trading software. I had scheduled myself to be in a weekend class to learn how to use the software. That was a long time back; but I can remember it vividly. What I planned to do was learn how to use the software and then apply it to the mutual funds in my 401K portfolio to determine when I should enter and when I should exit a mutual fund based on how it was doing.

So what was the first decent trading system that I learned and what do I think of it today?

The first system that I used came with the Metastock end-of-day software. It is called the CS Scientific Inc.- Hybrid Trade Screen. I pulled up a chart on one of my 401K mutual funds, clicked on expert advisor in Metastock and applied the trading system on my chart. Immediately it transformed itself from a black and white graph to a chart with a blue – red price line. When the price line was Blue it implied things were good and one should be long. Red implied not good, and time to exit. Quite simple really. Unfortunately all the mutual funds I had money in were red and told me I should get out. I was on the left free fall red line on the chart, and sliding. I was frozen. Yes, that was back in 2002.  Back then I had vowed to learn how to manage my money better as you can never count on who you can trust and who knows what they are doing with money, and who has a similar mind set as you for risk. See chart below of what one of mutual funds looked like back then in 2001-2002.

Eventually I was able to overcome my inaction and get out of the markets and put my money into a 401K money market type fund; but not till a lot of damage had been done. And as I continued to learn the nuances and tricks of using Metastock, as well as my own emotions, I lost less money and slowly got hardened and tempered in the markets. It was a hard time to learn trading 2001 – early 2003. I can say that I learned through one of the roughest times in the market. That learning also prepared me for 2008 when I was able to exit the market and protect my holdings through the crash of 2008 and get back in 2009. I think it is fair to say that learning takes time, and usually 4 – 5 years before you really understand the technicals and yourself. And by the way – the First trading system I liked is still pretty good, albeit a little choppy in sideways markets.

Market direction 2/13/11

Without doubt, my road to learning and using technical analysis would be short lived without software to support my analysis. Fortunately, an associate gave me a video on Steve Achelis pitching his software Metastock. I bought the software from Equis and over the years have bought all the upgrades as well as several add-ons. I would like to thank Steve for firstly creating such great software and for Reuters to keep the ball rolling after they bought out the company from Steve. I know others who started learning about technical analysis or options and who lost their way because they used software that was not friendly to changes and produced poor signals. Combining technical analysis with a software capable of accepting your input is a key to being successful.

Where is the market going? Below is a daily chart of SPY with an expert trading system that I have developed using Metastock. It is the first chart I like to open up. All I can tell from the chart is that there are Up arrows, signaling the market is still UP. It can change any day next week or can stay in this trend longer. No one really knows how long; but it is reasonable to expect a correction and pullback down the road.. With technical analysis I accept the current state and stay in a long mindset till things change and I get an  exit or down signal end-of-day. This type of information is very useful for the rest of the trading I will do with my 401K systems and dynamic hedge. The first step is always to know which way the tide is flowing. The SPY trading system has been signaling Up since September 2^nd, 2010, end-of-day.

  

You Haven't missed the bus (or is the bus not moving at all)

The lost Decade. They call the last ten years of investing the lost decade. It happened in Japan and has also happened in the US and other countries. Many of us that expected to double our money during the last ten years, only saw it stay flat and go up and down.. So how does one get out of this cycle and grow our accounts?

One approach, as outlined by a friend of mine and a well know Investment Guru in India, is to buy 10-15% dips and buy more than 2-3 stocks; more like 10-20. Buy stocks in companies that have good management and good growth, or companies you know well. Some of these stocks will lose money but overall the portfolio will grow.. This also assumes markets are random in nature and that all efforts to be predictive are hopeless.

Another approach, and one that I believe in, is that markets are random for a portion of the time but also predictive for a period. They are predictive during long uptrends when fear is gone, and steep downtrends when fear takes over and there is a herd mentality to head out the door. Technical analysis works well during these times, well enough to offset the uncertain random periods. Technical trading also helps keep drawdowns less. For buy-and-hold types, I will concede that in a strong uptrend, buy-and-hold can generate more profits than technical trading. Still, I prefer to take less risk as I cannot tolerate steep drawdowns.

I think the best method for a person is based on their mind set and what they can tolerate for loss. As your risk tolerance decreases, technical trading looks better and better. If you can stomach huge losses, then the first approach can be quite rewarding.

One last point is that we assume that markets will eventually always go up. If during our critical years the market heads down, then all bets are off for the first approach. I ‘ll take technical trading any day and make money whether the market goes up or down using dynamic hedging.

So we just hang in?

A friend writes “So we just hang in?” on the Indian stock market. I don’t track the Sensex or the local stocks in the Indian stock market, as I live in the U.S. But I do track IIF which is an India fund ETF. What has been happening to the IIF is what has been happening to the Indian stock market; and that is a broad reversal. So we just hang in?

Let us begin by looking at the IIF daily chart below done with Metastock software and an expert software trading system.

I see an exit Sell signal on the chart November 16th ,2010, when IIF was at $27.41. See the second red vertical line on the chart. That is when I would have exited on IIF. I would not be in the broad Indian stock market at all until conditions were better. IIF is now at $21.41; a drop of $6.00 from November and pain as we see our money going away over the last few months. This is why I like to use technical analysis and trading systems. They point the way to the door so that we can protect our money to make gains another day.

What would I do today if I was in IIF and saw this chart? I would get out. The indicators say the market is headed down and until it changes and generates an Up signal, I would stay out. We really cannot predict how long the down trend will last or whether this would continue for a long time. Perhaps it will turn around soon and I would lose some money had I stayed in and missed the immediate reversal. But it is better to learn technical analysis and follow systems in a disciplined way. That is the value I see in stock technical analysis.

Beginnings -1 First good read

How did I begin learning technical analysis? I remember going to the local library, reading a business magazine and finding the name Tokyo Joe – a famous day trader in the center page of the magazine. I subscribed to his on-line service just to learn what he was doing. I was no day trader and had no business subscribing to it of course. But Tokyo Joe had a unique writing style. He was knowledgeable and passionate about what he did.

I remembered his writing something like this:

“BOP is green,,, RSI turning up,,, and fast Stoch is moving up to.,, it’s a buy right here,,,’

That made no sense to me at all. Welcome to the strange world of technical analysis! It is another language to learn, in order to reduce risk and manage our money better. A much more sane way to learn technical analysis is to read Steve Achelis’ book, “Technical Analysis from A – Z”. 

It is a great read. It de-mystifies technical indicators. Says what each indicator is and shows an example of how the indicator can be used. Great book. It is still one of my favorites.

Review: A sprint to the finish...

I plan to do a few reviews with my blogs. Here is one on an article that my daughter Monica sent me.

"Save and invest diligently for 30 years, then cross your fingers and pray your investments will double over the last decade before you retire.”
--Tara Siegel Bernard, "Your Money: With Retirement Savings, It's a Sprint to the Finish"

This is exactly what financial advisors have you do, the article goes on to say.  The expectation is that your money will double every nine to ten years. Therefore you will need to see your money double over the last ten years for you to reach your goal. Someone who has $500,000 in their 401K retirement account, ten years back and was hoping to see it reach $1.0 million would certainly have been disappointed. The last ten years was a lost decade, meaning no money was made if you look at a major index like SPY or the S&P500.

The answer is to save more money early in your career. Then reduce the amount in stocks to reduce risk and a large loss. You are more likely to reach your goal that way. I agree with the writer. Great point.

But what about all of us who are older and who have been unable to compound our way to the finish line with the lost decade? Well here are some recommendations.

Increase the amount of money you are contributing into your 401K retirement fund to 15 – 20% of your salary from the 5-6% people like to put away. That is assuming you have a good paying job. I know many cannot afford this; but the money for retirement has to come from somewhere.

Next I would keep the stock to bond ratio in line with your risk tolerance. In order to achieve your goals, you will want to be able to handle losses without pulling out or deviating from your plan. Higher the stock to bond ratio, the greater the drawdown your account will go through during recessionary times. It is better to save more and reduce the stock:bond ratio to 50:50 and stick to a plan.

But what plan?
Diversified investments split into 4-5 equal diverse funds in your 401K would be a good start. Rebalancing once per year is better than frequent rebalancing once per quarter. The market takes a while to change direction and rebalancing works better when done less frequently. Rebalancing simply means going back to equal allocation at year end. That would mean you will take money out of funds that went up and put them into ones that went down. Once per year is often enough. Check with a reliable financial advisor on this. Personally I think using this method is better than no method at all.

I prefer another method – a momentum method based on putting all your money into the strongest top 3-4 funds. This requires logic to decide which are the top rising funds. A ranked comparison of all the funds in your portfolio can provide that useful nugget of information. Check that strategy out by back testing it. Don’t take my word for it.

And finally, use technical analysis to get out of large drawdowns before they occur.

Beginnings

When I look back, my beginnings in investing were very simple. I made a decision to invest a portion of my income into our 401K plan. Perhaps that is how many of us begin. I knew very little about the stock market and the amount of money was small. I cannot even recall where exactly I put my money into. There was little advice to go around back then. I stayed focused on my work and it was only after a few years that I started noticing that my 401K was growing and had equaled our rather small annual salary back then. I think that is when I started thinking about where should I portion my monies among the choices I had in my 401K? Since investing is a very personal decision, there was not much advice to go around. Anyhow, I chose to put my money into three equal portions – an income generating fund, an overall market equity fund, and the company stock. Fortunately the company stock went up through the 90s and we did rather well in the 90s.

But should one put money back into the company stock fund?
My answer for the majority of people would be “No” but with one exception. The answer No is given because most of us have all our lives tied into the company and maybe it is best we keep the investment separate in case the company tanks.

But for those who know stocks technical analysis or those who have devised a system based on thorough back testing of rules to follow to get in and out of the company stock that could be very rewarding. The company stock could rise much faster than industry mutual funds... I remember 2003 well. The stock market went up 28.8% that year after the terrible fall from the previous years. My investments in my company stock went up over 50% and I was able to enter on a technical signal, coupled with a nice rise in volume, which gave me confirmation that the market was changing its mind and further rises would be likely. After the stock rose 70%, I chose to take out half my money before earnings announcement, mainly because I did not know how the market would react to whatever our earnings would be, and I wanted to book some of the profits. I think looking back that showed me the value of technical investing better than I could have learned from a book.

Back test your trading system – follow your rules for entry and exit – take some profits along the way.